The Accounting Standards Codification (ASC) 606 revenue recognition
standard, introduced by the U.S. Financial Accounting Standards Board (FASB)
for fiscal years beginning after December 2017, represents a shift from
rules-based to principles-based revenue recognition. This new revenue
recognition paradigm offers financial statement preparers greater discretion
and judgement in deciding recognized revenues in current versus future years.
Therefore, the initial adoption of this new standard presented a unique
opportunity for earnings management that fit the preparers’ predetermined
goals. This paper takes this unique opportunity in the accounting practice to
examine whether financial statement preparers utilized the initial adoption of
such new principles-based revenue recognition paradigm to manage their reported
sales revenue as part of their earnings management effort.
The paper focuses on companies
in industries with complex, bundled contracts and products, such as the
software and high-tech sectors, in contrast to more conventional industries
offering simpler, stand-alone products and contracts, such as retail and
wholesale. Using a sample of companies that first adopted the new revenue
recognition standard in both high-tech and traditional industries, our findings
show evidence that preparers in the high-tech test group leveraged the more
flexibility provided by the new standard to manage reported sales revenue (in
contrast to their net operating cashflow) compared to preparers in the control
group of traditional industries and the years preceding the year of
adoption. The paper’s results have
implications for regulators, standard-setters, and investors, highlighting the
potential effect on financial reporting and the need to consider the
sector-specific nuances introduced by the new standard.
